By D.B. YOUNG

Contributing Reporter

Believing that doctors at Kaiser Permanente failed to detect his lung cancer, Wilfredo Engalla did what all Kaiser patients must do when they assert malpractice: file for arbitration.

The health maintenance organization requires members to sign agreements promising that an arbitrator will be appointed in 60 days or less. But it took Kaiser 144 days in the case of Engalla, a Hayward accountant.

Engalla died a day after an arbitrator was appointed dramatically reducing Kaiser's liability, since pain-and-suffering damages cannot be sought by survivors on behalf of the deceased.

In a landmark 6-1 ruling that grew out of the Engalla case last summer, however, the state Supreme Court said plaintiffs can take their claims against HMOs to court if they can show the arbitration process is flawed. This came after attorneys for Engalla's family showed that Kaiser took an average of 674 days to appoint a neutral arbitrator for malpractice cases, and an average of 863 days to hold an arbitration hearing.

The ruling, which resulted in Kaiser's decision this month to scrap its in-house arbitration service, reflects the growing role of the courts in the HMO industry.

Federal law says that only doctors not corporations can be held liable for punitive damages when a patient suffers ill health from bad medicine.

As a result, patients denied adequate care can sue their doctors when things go wrong. But when it comes to suing their HMOs, punitive damages are seldom allowed, and unhappy patients are usually limited to recovering the cost of the care they were denied.

Even so, a handful of lawyers have exploited loopholes to breech the wall protecting HMOs from major liability.

One of the most creative law firms at wringing liability dollars has been Hiepler & Hiepler of Oxnard, which won an $89.1 million judgment from Health Net in 1993 for the family of the late Nelene Fox. Fox's family sued Health Net after the HMO refused to pay for a bone marrow treatment for her breast cancer.

Hiepler & Hiepler partner James McGinley said the firm exploited a loophole in federal law that allows employees of government entities to sue their HMOs for punitive damages. Fox happened to be a public school teacher. (To avoid an appeal, the Fox family ultimately settled with Health Net for a lesser, undisclosed sum, McGinley added).

Hiepler & Hiepler scored a similar success in the case of another schoolteacher, Inland Empire resident Christine DeMeurers.

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